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Initiating Coverage NIIT Technologies Ltd 11 January 2012 Revenue to grow at a CAGR of 25%... Recommendation : OUTPERFORMER We expect NIIT Technologies revenue to grow at a CAGR of 25% CMP : Rs 200 Target : Rs 255 between FY11 – FY13 to Rs. 19,291 mn. Strong order book, higher Upside Potential : 27.69% domestic business and revenue flow from new deal i.e. Morris Communication and Eurostar gives thrust to our revenue assumption. Sector : IT&ITES Sensex : 16,165 Superior margin profile combined with low relative Bloomberg code : NITEC IN Reuters Code : NITT BO volatility in earnings… AT A GLANCE Earnings volatility is one the principal concern faced my midcap IT Outstanding Equity (shares in mn) : 59.43 companies and NIIT Technologies has got a superior margin profile with Mkt. Cap (Rs. in mn) : 11,886 relatively low volatility in margins. During the Period FY07-FY11, its Mkt. Cap (US$ in mn) : 230.35 operating margin was in the range of 18% ~21% with relative volatility Shareholding Pattern Promoters (%) : 39.18% 6%. Free Float (%) : 60.82% Order book gives revenue visibility… Background: NIIT Technologies was spun off from NIIT Ltd. It has got a strong prowess in application NIIT Technologies opening order book (executable in next 12 months) development & maintenance, system integration and enterprise solutions including managed services and has grown at a CAGR of 17.3% from US$76 mn in FY07 to US$169 mn BPO. As on September 2011, NIIT Technologies in FY12. Historically company revenue to opening balance of order book headcount stood at 6,733 people catering to clients was in the range of 1.9X ~ 2.6X (average of 2.1X for the period between across insurance, financial services, travel, FY07 – FY12). Our revenue estimates for FY12 is at the lower end of the transportation & logistics, manufacturing, retail and range (i.e. 1.9X of FY12 opening balance of order book) in the midst of healthcare. Its marquee client list includes British uncertain global economic condition. Airways, Saber, Changi Airport, ING Group, Amlin, AXA, SEI, Deutsche Bahn, Holcim and Thrivent. Outlook & Valuation: We expect NIIT Technologies to report an EPS of Rs. 31.3 and Rs. ANALYST 36.5 for FY12E and FY13E. At the CMP of Rs. 200 the stock trades at Sathyanarayanan M +91-44-30007361 6.4X and 5.5X to the FY12E and FY13E earnings respectively. We email@example.com have arrived at a target price of Rs. 255 is based on 7x FY13E EPS. We recommend NIIT Technologies as an “Outperformer” rating with a potential upside of 28% from current level. Particulars Pre-tax Net Adj.EPS EBIDTA PBT PAT Tax Revenue* EBIDTA* PE (X) (*Rs million) Profit* Profit* (Rs) Margin Margin Margin Rate FY11 12,323 2,404 2,178 1,822 30.9 19.5% 17.7% 14.8% 14.8% 6.5 FY12E 15,752 2,717 2,514 1,855 31.3 17.2% 16.0% 11.8% 26.1% 6.4 FY13E 19,291 3,377 2,967 2,165 36.5 17.5% 15.4% 11.2% 25.0% 5.5 Company Overview NIIT Technologies was spun off from NIIT Ltd. It has got a strong prowess in application development & maintenance, system integration and enterprise solutions including managed services and BPO. As on September 2011, NIIT Technologies headcount stood at 6,733 people catering to clients across insurance, financial services, travel, transportation & logistics, manufacturing, retail and healthcare. Its marquee client list includes British Airways, Saber, Changi Airport, ING Group, Amlin, AXA, SEI, Deutsche Bahn, Holcim and Thrivent. Business Model NIIT Technologies through its business model “Focus and Differentiate” has created a niche for itself, by focusing on selected industry segments i.e. insurance, financial services and travel, transportation & logistics (TTL), which contributes 75% of the company’s revenue in Q2FY12. It has delivered superior customer centricity which is evident from a long standing relationship with marquee clients such as British Airways with whom NIIT Technologies has been associated for 15 years, with SATS for 10 years and with Sabre for 8 years. NIIT Technologies is has been ranked no. 1 in Datamonitor’s Black Book of Outsourcing for the last three years (2008, 2009 & 2010) for customer service in the Travel segment and ranked No. 3 globally among all IT outsourcers. Revenue by Industry Vertical Source: Company, CSEC Research BFSI contributes 39% of companies revenue in Q2FY12 and most of it is through the insurance vertical (c.61%) and rest from banking and financial services (BFS) which contributes equally. Among BFS it caters to risk & compliance, investment management, community / cooperative retail bank. Its Marquee clients in BFSI include ING, SEI, NN, Amlin, Thrivent and AXA. Banking & financial services Vertical… Insurance Vertical… Source: Company Source: Company Travel, Transportation and Logistics (TTL) vertical contributes 36% of NIIT Technologies revenue in Q2FY12, which comprises of large carriers (35%), airports (18%), travel distribution (24%) and surface transportation (23%). It caters 50+clients and has a long standing relationship with clients such as British Airways (15 years), Sabre (8 years), Virgin Group (6 years) and Deutsche Bahn (5 years) Manufacturing & Retail contributes 8% of company’s revenue whereas other sectors (incl. Government) contribute 17% of the revenue. It offers turnkey projects for defence, paramilitary and power sector. It also offers GIS services. Revenues by Geographies NIIT Technologies generates 3/4th of its revenue from America (37%) and Europe (38%) with revenues from America growing at a CAGR of 14.8% during the period FY05-11, while the revenues from Europe grew at CAGR of 10.9%. Asia Pacific and India which contributes 13% and 12% of its revenue grew at CAGR of 18.1% and 22.5% during the same period. Revenue from Geographies… Asia Pacific (incl. India) revenue contribution… Source: Company Source: Company, CSEC Research Its combined exposure in Asia-Pacific and India is one of the best amongst its tier II peers; this provides relative comfort in the ongoing turbulent global macro economic scenario. Service Offering: Application Development & Maintenance: NIIT Technologies offers custom software development, application management, business intelligence, system migration and modernization. It also specializes in functional & regression testing, system testing and full lifecycle testing. Package Implementation: It offers ERP implementation of SAP and Geographic Information System (GIS) based solution around ESRI technology. It offers Geographic Information System (GIS) to clients worldwide. Domestically it has partnered with ESRI Inc, USA (global leader in GIS) through a JV to form a company called NIIT GIS Ltd, in which NIIT Technologies Ltd hold 88.9% and remaining share held by ESRI Inc. In FY11 GIS revenue stood at Rs.934 mn i.e. 7.6% of NIIT Technologies revenue share. GIS is a seasonal business with Q1 being the lowest, Q2 and Q3 moderate quarters and Q4 is the strongest quarter. Revenues from GIS have grown at Compound Quarterly Growth Rate (CQGR) of 8.34% from Rs.139mn in Q2FY10 to Rs.264mn in Q2FY12. Non Linear strategy: NIIT Technologies has transformed from a generic services provider to a specialized domain focused player. Its next phase of transformation involves increasing the revenue share from non-linear activity by evolving new service offering (managed services, platform based solution and cloud services) that provide higher value to its clients and higher margin to the company. NIIT Technologies’ non-linear revenue contribution currently stood at 27% (i.e. managed services contributing 13% and platform based solutions contributing 14% of revenue) which the highest amongst its Indian peers. Managed Services: Company manages IT infrastructure and application as completely administered services to their clients which include Holcim. It contributes 13% of its revenues. Platform Based Solutions: NIIT Technologies offer platform based solutions which contributes 14% of its revenues. It offer solutions based on its own platform or through partnership. Source: Company, CSEC Research Cloud Services: NIIT Technologies provides cloud services such as Software-as-a-Service (SaaS), Platform-as-a-Service (PaaS) and through its partnership with Hitachi, Thailand it also offers Infrastructure-as-a-Service (IaaS) where Hitachi owns the cloud and NIIT Technologies manages the cloud. According to NASSCOM, the global cloud market is projected to grow at 33% CAGR to reach US$680bn by 2020, while the Indian cloud market is expected to reach US$16bn in the same period. While cloud will create and utilize some of the existing service line for IT and BPO companies, it also opens up a whole new opportunity to play along the cloud services. Globally, SaaS the largest segment is expected to contribute US$244bn by 2020 and IaaS the second largest segment is expected to reach around US$143bn by 2020, while PaaS segments which has been largely restricted to create SaaS applications, however could potentially transition to standalone development and deploy platforms. Investment Rationale Superior margin profile combined with low relative volatility in earnings… Earnings volatility is one the principal concern faced my midcap IT companies and NIIT Technologies has got a superior margin profile with relatively low volatility in margins. During the Period FY07-FY11, its operating margin was in the range of 18% ~21% with relative volatility 6%. Operating Margin Relative Company Volatility FY07 FY08 FY09 FY10 FY11 volatility NIIT Tech. 20.4 18.7 18.0 20.7 19.5 1.1 6% Polaris 16.5 12.4 14.7 15.9 17.2 1.9 12% Persistent Systems 27.7 26.7 16.3 26.2 24.8 4.6 19% Hexaware* 18.6 14.3 9.2 16.8 9.7 4.2 31% Mindtree 19.9 20.8 11.2 24.9 13.4 5.6 31% Infinite Computers 4.7 7.8 13.2 16.8 17.6 5.7 47% Source: CSEC Research Superior margin profile and low volatility in earnings are attributed to higher non-linear revenue share and its specialized focus (verticals) yielding pricing power. Increasing non linear revenues to aid margin… Currently 27% of revenues are derived from non-linear revenue source, which typically has higher margin compared to the linear revenue source. Recently NIIT Technologies has won new deals from Morris Communication and Eurostar, which will contribute to the non-linear revenues share, and we expect the revenue share to reach ~30% in FY12. Source: Company, CSEC Research Morris Deal: Through the deal with Morris Communication, NIIT Technologies has forayed into the media space in the form of a JV (NIIT Media Technologies). Morris Communication will hold 40% (will move its assets and 100 consultants to JV Company) and NIIT Technologies will have a 60% share for which it will invest US$3.2mn. JV will have a revenue commitment of US$85mn from Morris Communication for 5 years to offer managed services (Integrated IT and BPO services). Though, the Morris deal may not contribute any margins in FY12, going forward higher off-shoring from Morris likely to yield positive margins. In Q2FY12 for ~1.5 months of operations, NIIT Media Technologies reported revenues of Rs.75 mn (US$1.7mn) and a loss of Rs.98mn (due to one time legal and professional fee of US$2.5mn). Going forward revenue contribution from the JV is likely to increase up to US$5mn per quarter. Learning curve benefits of the JV will help in winning more such deals in the media space, moreover, Morris Communication has offices across the US, UK, France and Asia, which will act as a near shore centers. Eurostar deal: In Q1FY12, it signed a large deal with Eurostar to provide managed services. NIIT Technologies will create the infrastructure and charge on a utility basis. NIIT Technologies is likely to invest £3mn (US$4.68mn) on infrastructure. During Q2FY12, revenue contribution from the deal was insignificant as the project was under a transition period; however, starting from Q3FY12 it will contribute significantly to the top line. Though the domestic businesses (Government business) mount pressure on margins, we believe increase in non linear revenue will provide a cushion to margin. Order book gives revenue visibility… NIIT Technologies opening order book (executable in next 12 months) has grown at a CAGR of 17.3% from US$76 mn in FY07 to US$169 mn in FY12. Historically company revenue to opening balance of order book was in the range of 1.9X ~ 2.6X (average of 2.1X for the period between FY07 – FY12). Our revenue estimates for FY12 is at the lower end of the range (i.e. 1.9X of FY12 opening balance of order book) in the midst of uncertain global economic condition. Source: CSEC Research At the end of Q2FY12, NIIT Technologies’ order book (executable in next 12 months) stood at US$232 mn, thus indicating strong revenue visibility. During the quarter new orders worth US$200 mn,including orders from CCTNS worth US$40 ~45mn and Morris Communication deal worth US$85 mn, were bagged from 7 clients. The outsanding order book and new orders are amongs the highest in its hisory. Source: CSEC Research Domestic business to support revenue during global uncertainties… Amongst tier II players, NIIT Technologies has got one of the highest exposures to Indian and Asian markets with 15.7% and 13.8% of revenues in FY11. Revenues from these geographies grew faster than the companies average (CAGR of 14.6%) at a CAGR of 22.5% and 18.1% from FY05 to FY11. Source: CSEC Research Domestic business accounts approximately for 20% of order book. This gives comfort amidst global uncertainties. After successfully completing the Rs. 2,290 mn worth Border Security Force (BSF) deal (won in Q4FY10), NIIT Technologies has won an another large deal from the Indian Government worth approximately US$40 – 45 mn in Q2FY12 under Crime and Criminal Tracking Network & Systems (CCTNS) program to implement in two states. The deal was won under stiff competition from both domestic and international players. CCTNS program is one of the 27 mission mode projects under the Rs. 230,000 mn national e- governance plan. The CCTNS deal likely to have higher hardware component (approximately 65% ~75% of the deal) and the revenue from the deal will start flowing in from Q4FY12. Going forward this throws the door wide open for NIIT Technologies to bid for more such government projects. Inorganic growth – an integral element of growth strategy NIIT Technologies has pursued acquisition and collaboration as integral part of its growth strategy. Through this strategy it forayed into new geographies, emerging technologies, strengthen its technical capabilities, expanded its customer base. In 2002 NIIT Technologies acquired AD Solutions AG (ADS), a German IT company headquartered in Germany with subsidiaries in Austria and Switzerland. This acquisition facilitated NIIT Technologies to expand its foothold in Germany, Switzerland and Austria. It also helped the company to build a strategic relationship with Deutsche Bahn (German Railways). In May 2006, NIIT Technologies acquired a major shareholding in Room Solutions, through which it got access to the Lloyds insurance market. NIIT Technologies has turned around operations of Room Solutions. In Q2FY07 operating margins were 4%, through synergy and process integration operating margin have improved substantially to 27% in Q2FY12. During this period revenues have grown to Rs 398 mn at ~9.4% CAGR. Source: Company, CSEC Research In FY11, NIIT Technologies foray into healthcare business in US, by acquiring an electronic health records and referral management platform called “Preferr” (Patient Referral System) enables collaboration between all providers namely physicians, hospitals, diagnostic facilities and laboratories. In August 2011, NIIT Technologies acquired Spain based Proyecta Sistemas with revenue of about US$10 mn (Travel accounts for 68% of revenue, 23% from BFSI and 9% from others) with EBIDTA margin of 10%. Through this acquisition it got access to marquee clients such as Iberia, Solimat and Pullmantur in the travel space and Merrill Lynch, Santander and BBVA in BFSI space. Moreover through this acquisition will facilitate a foray into other Spanish speaking countries in Latin America. It would also use Proyecta as a near shore center and providing technology backend from India. Joint Venture: NIIT Technologies has been partnering with ESRI Inc, USA, when it began reselling and supporting ARCInfo software. In 1996, the collaboration evolved into a strategic relationship to form a JV to provide GIS in India. This collaboration has enabled NIIT Technologies to access ESRI Inc, know how on GIS services. In FY11, NIIT Technologies GIS revenue stood at Rs. 934 mn i.e. 7.6% of company’s revenue. Source: Company, CSEC Research Financials Revenue to grow at a CAGR of 25%... We expect NIIT Technologies revenue to grow at a CAGR of 25% between FY11 – FY13 to Rs. 19,291 mn. Strong order book, higher domestic business and revenue flow from new deal i.e. Morris Communication and Eurostar gives thrust to our revenue assumption. Source: CSEC Research Going forward margins to be under pressure… We expect NIIT Technologies margins to come under pressure due to low margin from hardware component of Crime and Criminal Tracking Network Systems (CCTNS) deal, investment in SG&A and margin pressure from new deal wins (Since the Morris deal is in transition period it will not contribute any margins till Q1FY13) and Proyecta acquisition having low operating margin of ~10%. Source: CSEC Research However, higher non-linear revenues, rupee depreciation, higher off shoring from the Morris deal and a broadening employee pyramid (management plan to broaden the base of employee pyramid. Currently the proposition of employees with <3yrs of experience is ~30%, and it will be increased by hiring more fresher’s in FY13) will curtail margin erosion. Source: CSEC Research We have penciled in a 226 bps drop in operating margins in FY12 to 17.2% and a 30 bps improvement in FY13 by 30 bps to 17.5%. We have assumed a tax rate to be 26.1% and 25% for FY12 and FY13 respectively. We expect a PAT margin of 11.8% and 11.2% in FY12 and FY13 respectively. Outlook & Valuations: We expect NIIT Technologies to report an EPS of Rs. 31.3 and Rs. 36.5 for FY12E and FY13E. At the CMP of Rs. 200 the stock trades at 6.4X and 5.5X to the FY12E and FY13E earnings respectively. We have arrived at a target price of Rs. 255 is based on 7x FY13E EPS. We recommend NIIT Technologies as an “Outperformer” rating with a potential upside of 28% from current level. Source: CSEC Research Financials Income Statement (Rs. million) Cash flow Statement (Rs. million) Particulars FY10 FY11 FY12E FY13E Particulars FY10 FY11 FY12E FY13E Net Sales 9,138 12,323 15,752 19,291 Growth % -6.8% 34.9% 27.8% 22.5% Net Cash from Operations 1,475 663 1,658 2,172 Operating Expense 7,249 9,919 13,035 15,914 Operating Profit 1,889 2,404 2,717 3,377 Net Cash from Investments -925 -374 -703 -998 Depreciation 360 315 397 521 Other Income -109 89 194 110 Net Cash from Financing -607 -549 -652 -636 PBT 1,420 2,178 2,514 2,967 Tax 144 323 656 742 Net Increase in Cash -57 -259 302 538 PAT 1,276 1,855 1,858 2,225 Minority Interest 13 33 3 60 Closing Balance of Cash 1,430 1,194 1,496 2,035 PAT after Minority Int. 1,263 1,822 1,855 2,165 EPS 21.5 30.9 31.3 36.5 FCF 1,061 182 887 1,164 Balance Sheet (Rs. million) Ratios Particulars FY10 FY11 FY12E FY13E Particulars FY10 FY11 FY12E FY13E Share Capital 588 593 593 593 EBIDTA% 20.7% 19.5% 17.2% 17.5% Share Application Money 0 0 0 0 PBT % 15.5% 17.7% 16.0% 15.4% Reserves and Surplus 5,210 6,886 8,176 9,765 PAT % 13.8% 14.8% 11.8% 11.2% Minority Interest 28 43 49 49 RoE% 26.1% 27.4% 22.8% 22.6% Borrowings 217 110 110 110 RoCE% 36.7% 35.2% 32.8% 34.7% Total Source of Funds 6,043 7,631 8,928 10,517 Tax% 10.1% 14.8% 26.1% 25.0% Debtors (Days) 80 109 109 109 Net Block 1,853 1,893 3,544 3,891 Creditors (Days) 39 36 39 39 CWIP 1,287 1,437 160 300 CEPS (Rs.) 27.6 36.2 38.0 45.3 Investments 465 443 450 450 DPS (Rs.) 7.0 7.5 8.0 8.5 DTA (Net) 107 143 143 143 Net Current Asset 2,330 3,715 4,632 5,734 Total Application of Funds 6,043 7,631 8,928 10,517 Cholamandalam Securites Limited Member: BSE, NSE, MSE Regd. 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